Why will an inflationary GDP gap cause further inflation?

Question

Multiple choice question.

Because input prices rise in the long run in order to meet the increase in output prices

Because output prices rise further as production decreases

Because input prices rise further as production decreases

Because output prices rise in the long run in order to meet the increase in input prices

Answer 1

The correct answer is:

Because input prices rise in the long run in order to meet the increase in output prices.

An inflationary GDP gap occurs when actual GDP exceeds potential GDP, leading to upward pressure on prices. As demand for goods and services increases, firms may raise their output prices. In the long run, this can lead to higher costs for inputs (wages, materials, etc.) as businesses compete for resources and labor, further fueling inflation.